Abstract
We describe the functioning of a two-region economy characterized by asymmetric wage setting. Labour market tightness in the leading-region affects wages in the whole economy. In equilibrium, net labour demand shifts towards the leading region raise unemployment elsewhere and leave regional wages unchanged, causing an increase in aggregate unemployment. Based on SHIW micro-data on earnings, we find strong evidence that wages in Italy only respond to Northern unemployment. We estimate that around 33% of the increase in Italian unemployment during 1977–1998 can be explained by regional mismatch, mainly due to an excess labour supply growth in the South.
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